The Law of Diminishing Marginal Returns

One of the popular laws in the theory of economics is the law of diminishing marginal returns. This law states that as the application of one factor of production is increased continuously, marginal product of that factor increases up to a certain point until it reaches a maximum and thereafter it begins to fall and eventually the marginal product of each additional factor of production becomes negative.  When the marginal product reaches zero level, total production can be said to have reached the maximum level.  When the marginal product of that factor is negative, total product starts falling.  This particular theory, as with many economic theories, is framed under the assumption that all of the other factors of production are kept constant.

One of the classic examples of the law of diminishing marginal returns is the use of fertilizers in agriculture. Increased application of fertilizers augments agricultural production, but only up to a certain extent. Once that point is reached, increased application of fertilizers no longer increases agricultural output, rather agricultural output starts declining.  Once the maximum amount of production is reached, the law of diminishing marginal returns starts operating and marginal increases in agricultural output begins to decline.  In the case of fertilizers, this occurs because with increased application of fertilizers, the fertility of the soil increases up to a certain extent.  However, as the application of fertilizer to the soil increases, the fertility of soil no longer improves, rather it starts degrading.  As a result, the agricultural production of the soil starts to decline. 

Another oft-cited example of the law of diminishing marginal returns is the addition of more workers on a car assembly line.  Up to a certain point, the addition of more workers results in the production of more cars. However, after that point, the addition of more workers no longer leads to the production of more cars. In fact, quite the opposite may happen.  Some workers may find others in their way making it difficult to perform their respective tasks while other workers may now have to wait to get access to a certain part, etc.  In this chaotic situation, the production of cars may actually start falling relative to the additional inputs of labor.

Many large scale examples of this law can be observed today.  In an attempt to expand or develop at any cost, the countries of the world have engaged in a widepsread unmindful use of resources. The time is approaching where we may soon see the complete depletion of valuable natural resources. The tremendous proliferation of the usage of petroleum products and natural gas threatens the environment.  Emissions of CO2, greenhouse gases and unchecked deforestation of timberlands have added to the danger of disruptive climate change.  Meteoric increases in the usage of cars and electronic gadgets have created some negative side effects as well.  As an indirect result, human civilization may be more vulnerable to various types of diseases and natural catastrophes.

These examples all point to the operation of the law of diminishing marginal returns. The law can also be applied to personal finance. If one takes on more and more credit card debt in order to pay off other existing debts, the consequences can indeed be grave and ultimately the individual may have to file for bankruptcy.  Discipline and restraint are advisable in all fields of life.  Otherwise, human civilization will  continue to be threatened as the day of reckoning approaches.

Editor’s Note: This page was originally authored by our guest contributor here at The Mint, Mr. Jason Holmes.  Mr. Holmes is a regular contributer at Debt Consolidaton Care and various other financial websites and has authored several e-books.

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